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topic with us is called time interest on ratio now let’s talk about this in a
detail format you know over here we have an example or a graph of Volvo AB Times and their interest that is the turn ratio is closely 15.83 I’m now going to take you
directly you know what does this mean or how much times what exactly is the
interpretation no first let’s understand a step by step what this ratio is all
about we’ll get back to this and then we’ll analyze that you know what Volvo’s
times interest earned is increasing every year and what does this 15.83 shows us so let’s begin on that so first what is the times interest earned ratio what is
this well C times interest on ratio is basically again a solvency ratio which
measures the ability of the organization to pay its debt obligation also it is
known as we can see that it is interest coverage ratio the lenders commonly use
it to a certain if the borrower can take on the additional own the times interest
ratio is calculated by dividing the earnings of the company before it pays
interest by the interest expense or the ratio is division by simply earning
before interest and tax to interest expense so we wrote from the chart that
saw over here of Volvo if we just try and see look at the analysis we note
that from the about chart of Volvo’s times interest has been steadily
increasing over the time and this is very good situation to be in due to the
company’s increasing capacity to pay interest you can see from 2014 to 2017
and then it goes on and on the graph of is just going up so it’s really good so
analysts should consider but time series of the ratios a single point
ratio may not be very good measure or it may include one time revenue or earnings
but companies with consistent if you see consistent the ratio over a period of
time does indicating you know it’s a better position to service the tip
however you know the smaller company and startups which do not have consistent
earning will have variable duration they will have a
variable ratio over times with us lenders do not prefer to give loans or
to such companies and you know this companies offer higher equity and they
raise money from the private equity venture capital that’s we see let’s
understand this formula now let’s get to the next step that is the formula the
times interest earned formula is equal to EBIT/ interest expense this is the
formula so clearly the ratio gives how many times you know the interest can
cover the interest expense – its pre-tax in pre interest earnings the banks and
the financial lenders often look at various financial ratios – to mind the
solvency of the company and whether it will be able to service its debt before
taking on more debt so the bank’s look at the debt ratio the D to E Debt to
equity ratio and the times interest earned ratio often you know that ratio
and debt to equity ratio if you see for this one is a measure of the capital
structure of the company and it indicates the exposure of the company to
debt financing relative to the assets were equity respectively but however I
know the times interest over here this ratio measures if the company is earning
enough to pay off its interest now high times interest earned ratio is favorable
it is good it’s not bad it is good as it indicates the company is earning
higher than it is and will be able to service its obligation whereas you know
if see for the lower values it indicates the company may not be able to fulfill
the obligations but that may be the case now you need to know that you know many analysts use EBITDA in the numerator instead of the EBIT which I think you
know absolutely fine if you use it consistently over the years that’s
that’s good there’s no problem in that it’s a good measure it’s a good driver
does you know the new ratio becomes you know the time interest on ratio if you
just want to change over here instead of EBIT now this is the extra knowledge
you know I am sharing with you that in or fifth instead of over here if the
companies are like airline companies they have huge rental then you need to
add over here R that is a rentals EBITDA times interest coverage you know
sometimes they take EBITDA are also or a EBITDA if they are paying fees so it
depends upon company to company you which industry in which they are
operating so this is done because you know depreciation amortization expense
are here they count you know not actual cash outflows it doesn’t go out from
your pocket so for the given period so does removing such what we can see
here if you remove such ena over here you know it reflects better earning or
past you the company to pay interest expense arguably the depreciation and
amortisation spends in directly relates to the what
we call as the future business it needs to buy fixed and intangible assets and
thus you know the funds may not be available for the payment of the
interest expense this was the formula now let see the
calculations on the seam let’s take an example here suppose that let’s say you
know you have two companies one is alpha and another one is beta in a similar
industry so the two companies have you know some data over here as below like
you know alpha data and beta well the data of a bet is given 15 million
and 10 million interest expense 5 million 7 million
so in this scenario the company’s alpha is going to EBIT divided by interest
expense and control are so 1.42 so in the above example we can see
no the company alpha has higher times interest on ratio than the company beta
and those relatively company alpha is better financial position than company
beta and the lender will be more willing to give additional debt to alpha then
company to beta so the times through interest ratio of the company beta is
greater than one which indicates that it generates sufficient earning to cover
more interest payments does you know the lenders may look at the other factors
they may look at the other factors like you know debt ratio that to equity
industry standards to decide so companies with the times interest ratio of
if you say less than one are unable to service their debt so they cannot meet
their interest requirements from their owning and they must dig into their
reserves to pay off the obligations now I’ll take you to the Advantage part now
what is the advantage of this of this ratio see it is very easy to calculate
the times interested is indicated or indication of solvency of the company
the ratio can be used as an absolute measure of the financial position you
know the ratio can be used as a relative measure to company two or more companies
and the negative ratio indicates in the company’s are serious financial troubles
now if you see for the disadvantage over here although a good measure of solvency
the ratio has its disadvantage you know we’ll have a look at the floors and that
you know the bad drops of calculating this ratio the first thing is that you
know the earning before interest tax used in the numerator in accounting
figure which may not be representative a EBIT we are talking about enough cash
generated by the company so the ratio could be can be higher it can be lower
it does not indicate the company has actual cash to pay the interest expense
that’s a flaw the amount of the interest expense used in denominator of the ratio
is again an accounting measurements discount they have interest expense to
be paid so towards such issues it is advisable to use the interest rate on
the face of the bonds the ratio only considers the interest expense it does
not account for the principle payment so the principle payment may be huge it
leads to the company to insolvency but further the company may be bankrupt or
may have to refinance what we call as at the higher interest rates and
unfavorable terms so those while analyzing the solvency of the company
are the ratios like debt and equity debt ratio should also be considered
let me give my final thoughts on this C times interest alone ratio measures the
company solvency and its ability to service its debt obligation so this
ratio is indicative of the number of times the earnings to the interest
expense of the company so higher the ratio is better is the financial
position of the company and it is better candidate to raise more more funds and
moded so a ratio of greater than 1 this favorable however lenders should not
rely on the ratio unknown to decide other factors and ratios like debt ratio
that equity industry and economic condition should also be considered
before lending so that’s it for this particular topic if you have learned and
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